The clauses before you start

The clauses before you start


3 min read

Do not lose control over your project! It sounds alarming but the entrepreneur must carry out an exercise in awareness of the risks involved in a negotiation such as an agreement between partners and investors.

One way to do it´s to know the clauses to discuss at the same time you get informed about the problems that may arise in the development of the project. There are some of them:

  • Right of pre-emptive assumption: It serves to ensure the right that the partners have from the beginning, before the capital increase and their duties increase proportionally to their rights.

  • Issue Premium: It involves including an issue premium to the capital increase of the new capitalist partners. They will have to pay not only the nominal value but also the increase in value that the company obtains. The issue premium is the difference between the issue value and the nominal value of the shares.

  • Anti-dilution clauses: Investors request them. It ensures that the beneficiaries do not lose a percentage of their social capital in subsequent rounds. They claim that the pre-money valuation of a later round is not less than the post-money value of the round they entered. This is a very detrimental clause for the entrepreneur since he will be the one who assumes the cost of the expansion that his partners do not do in new rounds.

  • Upside Clause: With this, you accept a lower valuation of your company, but if certain milestones are achieved, the entrepreneur obtains an Upside with which he recovers part of the power that he lost at the beginning. Investors agree to give up a part of their shares if the entrepreneur manages to achieve those objectives. You have to make sure that the goals are reasonable.

  • Preferred Liquidation: From the beginning, the investor will have a strategy that allows him to get out of the project in the future obtaining benefits, so he will want to force the clauses in that direction. This clause allows the company to be sold for less than the current value, in addition to the fact that investors always charge first, then the entrepreneur. It can also apply in case of bankruptcy. The result is that the investor will receive several times his initial investment and the rest is distributed according to the shares between the investor and the entrepreneur. This clause should be avoided or minimized as much as possible.

  • Drag Alone: Determines that after a certain period an offer is received and 50% of the partners accept, it is mandatory to sell or acquire the shares of the investor who wants to sell for the value equivalent to the sale. Ideally, that time should be as short as possible.

  • Veto Clause: This clause decreases the management power of the entrepreneur. They limit your decision on issues such as new contracts, capital increases, change of registered office and even on everyday problems.

As you will have noticed, all these clauses cover several points that reduce your power in the company. That is why you must learn to value your Startup; no one knows her better than you.

Using, for example, the "discounted cash flow method", which consists of discounting today the cash flow that the project expects to receive in the future using an appropriate discount rate. In the beginning, the risk is greater, so the discount rate is around 33% or 55%.

The “multiple or comparable methods” (the usual one) consist of analyzing the value of companies similar to ours. The “dilution method” sets your valuation based on financial needs and the percentage of shares you are willing to give up.

Finally, the "risk capital method" is about determining a time frame and the fair value of the project to know what value it should currently start from.

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